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The biggest tumble in developing- nation stocks in 11 months is making investment strategists at Morgan Stanley, Credit Suisse Group AG and Goldman Sachs Group Inc. as bullish as ever.
Morgan Stanley's Jonathan Garner predicts the MSCI Emerging Markets Index will surge 34 per cent by the end of 2010 as corporate profits jump 40 per cent. Sakthi Siva of Credit Suisse says declines in the 22-country gauge may be limited to 5.3 per cent. Goldman's Thomas Deng recommends investors buy in China, where he forecasts the CSI 300 Index will gain 36 per cent in the next 10 months.
The strategists say developing markets are showing parallels with May 2004, when the MSCI index recovered from a two-month tumble of 11 per cent to rally 26 per cent by the end of the year. Like then, investors are pulling money out of emerging-market funds on concern lending curbs by China and interest-rate increases from India to Brazil will restrain economic growth.
"The emerging world is going to come out of this in stronger shape," said Julian Mayo, investment director in London at Charlemagne Capital, which oversees about $3 billion. "This is one of the speed bumps along the way. 2004 ended up being a good year for emerging-market investments."
The MSCI gauge lost 13 per cent from its 2010 peak on Jan. 11, the biggest decline since a 16 per cent drop that ended March 2, 2009. The index slid 0.4 per cent to 894.07 as of 6:36 a.m. in New York. MSCI Inc.'s measure of advanced-nation shares declined 0.2 per cent today, bringing its drop from a Jan. 14 high to 9.5 per cent.
Gazprom, Vale
Moscow-based OAO Gazprom, Vale SA of Rio de Janeiro and Industrial & Commercial Bank of China Ltd. in Beijing led a retreat of developing-nation energy producers, raw-materials companies and lenders after policy makers in China and India raised banks' reserve requirements last month to slow credit expansion in the world's fastest-growing major economies.
Emerging-market stocks also sank as state-controlled Dubai World failed to present a restructuring plan for $22 billion of debt and speculation increased that Greece, Spain and Portugal may struggle to repay lenders as their budget deficits widen.
"Everyone was feeling very sanguine about China going into the fourth quarter and now you've got tightening measures," said Nikhil Srinivasan, who helps manage about $30 billion as chief investment officer for Asia and the Middle East at Allianz Investment Management in Singapore. "Greece is a problem, not because it's a big country, because it's the eurozone. That's a problem for risk."
Fund Losses
Institutional investors pulled $1.6 billion from emerging- market mutual funds during the past two weeks, while individual investors withdrew $612 million, according to Cambridge, Massachusetts-based research firm EPFR Global. Professional and private investors took out a combined $1.4 billion from emerging-market funds during the third and fourth weeks of the 2004 retreat, EPFR data show.
Chinese policy makers helped spark the 2004 selloff in April as they raised reserve requirements for banks and told lenders to stop financing overheated industries, spurring concern the government would increase interest rates from the lowest levels on record.
The MSCI gauge fell 11 per cent in April and May, then rebounded 26 per cent through the end of the year as developing- nation economies grew 7.5 per cent and corporate profits jumped 66 per cent, according to data compiled by the International Monetary Fund and Bloomberg.
Aronstein Turns Bearish
"This looks like 2004," Siva, Credit Suisse's Asia Pacific and global emerging-market strategist in Singapore, wrote in an e-mailed note Jan. 26, advising investors to buy shares if the MSCI index falls to 850, or 5.3 per cent below its closing level last week.
The IMF predicts developing countries will expand 6 per cent in 2010 and 6.3 per cent next year, according to its January World Economic Outlook report. The MSCI gauge is valued at 12 times analysts' profit estimates, compared with a price-to- earnings ratio of 14 in April 2004, according to Bloomberg data.
Profits at MSCI index companies will rebound 40 per cent in 2010 after a 15 per cent decline last year, according to Garner, the chief emerging-market strategist at Morgan Stanley in London.
Developing-nation stocks are among the world's riskiest because investors drove prices too high on overly optimistic expectations for earnings and economic growth, said Oscar Gruss & Son Inc.'s Michael Aronstein.
Record Fund Flows
Investors poured a record $64.5 billion into emerging- market equity mutual funds in 2009, according to EPFR Global. Developing markets were the most-favored among global money managers surveyed by Charlotte, North Carolina-based Bank of America Corp. last month.
"If you look at the amount of money that's flowed into these funds, it's stunning," said Aronstein, chief investment strategist at Oscar Gruss in New York and manager of the $117 million Marketfield Fund. "That's where the retail investing public has an awful lot of exposure as well as many institutions. We're short in a pretty big way."
Aronstein said he's using emerging-market exchange traded funds and American depositary receipts, or ADRs, to bet developing-nation shares will drop. In a short sale, an investor borrows a security and sells it, expecting to profit from a decline by repurchasing it later at a lower price.
Earnings Beat Estimates
MSCI's emerging-markets gauge is still 33 per cent below its 2007 record, even after rallying 97 per cent from a four-year low in October 2008. Valuations in China, the biggest developing market, are half what they were at their all-time high in 2007. The CSI 300 trades for 26 times earnings, compared with 52 at the gauge's peak, Bloomberg data show.
China's lending slowdown may benefit the domestic economy by reducing risk, and investors should still buy shares of the nation's banks, Mark Mobius, who oversees about $34 billion as chairman of Templeton Asset Management, said in a Jan. 27 interview in Sydney. Goldman's Deng says the government is taking "prudent" measures to prevent asset bubbles and predicts the CSI 300 will climb to 4,300 by the end of 2010 from its closing price last week of 3,153.09.
"Strategically we're still positive on the market," Deng, the head of China strategy at Goldman in Hong Kong, said in a Jan. 21 interview with Bloomberg Television.
Company analysts remain bullish on emerging markets, predicting an average gain of 21 per cent for stocks in the MSCI gauge over the next 12 months, according to more than 1,500 price estimates compiled by Bloomberg. Among companies in the index that reported fourth-quarter earnings so far, 49 topped estimates, compared with 34 that trailed projections, Bloomberg data show.
"It's similar to the environment of 2004," said Morgan Stanley's Garner. "We should have pretty strong economic and corporate profits growth."
